Abstract
In this paper, we try to analyse the extent to which a redefinition of the monetary policy rule would help to avoid the zero-lower bound, as well as to explore the conditions needed to avoid that constraint. To that aim, we estimate the threshold values of the key variables of the policy rule: the inflation gap and the output gap. The threshold model allows us to know which are the turning points from which the relationship between the key variables and the interest rate revert. In the Eurozone countries, we have found that the inflation gap always contributes to increasing the nominal interest rate. On the contrary, the output gap works differently when it reaches values above or below the threshold value, which would favour the reduction of the interest rates towards the zero level.
Highlights
After the 2007–2008 crisis, there has been “a shift of policy away from rules as rates were held too low for too long” [1]
According to our results, when the output gap increases below 2.4289%, the relationship with the nominal interest rate is negative, leading to a negative marginal effect that implies a reduction of − 0.1394 points in the interest rate
Given the evidence that monetary policy has been constrained by a lower bound of the nominal interest rate, we have intended to study to what extent the values of the inflation gap and the output gap would contribute to being or not close to the zero lower bound (ZLB)
Summary
After the 2007–2008 crisis, there has been “a shift of policy away from rules as rates were held too low for too long” [1]. After the financial crisis, and, more recently, in the context of the Post-COVID era, authors like [13,14,15,16], among others, argue about the irrelevance of the zero lower bound (ZLB) constraint assuming a fiscal dominant environment where the central bank is forced to support fiscal solvency Those contributions are a way of recognizing that when reaching interest values close to zero, an expansive fiscal policy would remedy the ineffectiveness of monetary policy which, at the same time, would help finance fiscal solvency.
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